Monday, August 20, 2012 - Diminished Expectations

Diminished Expectations
-by Sinclair Noe


DOW – 3 = 13,271
SPX -0.03 = 1418
NAS -0.38 = 3076
10 YR YLD un = 1.81%
OIL - .05 = 97.70
GOLD + 5.40 = 1622.20
SILV +.72 = 28.91
PLAT + 12.00 = 1496.00

Apple already boasts the largest market value of any public company. Today it became the most highly valued public company ever. With an increase in its share price, Apple broke the record for the biggest market capitalization, $616.34 billion, set by Microsoft on Dec. 27, 1999. Of course, shortly thereafter, Y2K hit and destroyed modern civilization as we know it; or maybe it was because Apple invented the iPod and the iPhone and the iPad, and Microsoft gave us Zune. Who knows?  Apple’s stock closed at $665.15, giving it a market value of $623.52 billion. Microsoft’s 1999 market value is still far higher than Apple’s when adjusted for inflation. The Microsoft of late 1999 would be worth $850 billion in today’s dollars. To beat Microsoft’s inflation-adjusted market value, Apple needs to close at $910. The Microsoft of August 2012 is worth $257 billion.

I'm not sure what it says about our economy, that Apple is the most valuable company ever, but I suspect it is problematic. 

ECB President Mario Draghi is scheduled to speak at this year's Jackson Hole symposium. A fellow named Ben Bernanke is already scheduled to speak at the symposium, and so there has been a little speculation that there might be some coordinated action that will be announced. I'm not sure the ECB has learned the meaning of coordination. 

German magazine Der Spiegel said over der weekend that der ECB was considering buying debt issued by member countries if their interest rates became too elevated; the idea is unlimited bond buying to cap interest rates, but a bank spokesman said it was misleading to report on yet-to-be decided matters.

Germany's central bank, the Bundesbank, also on Monday reiterated its opposition to bond purchases, and a spokesman for the German Finance Ministry said it was not aware of any plans for the ECB to target bond spreads. It is a little tricky to figure out exactly what position Germany is taking, but they seem to benefit for the ongoing crisis; Germany is considered a safe haven of sorts. Spain is still a basket case. Technically, Spain can't receive aid until they make a formal request for aid; they haven't requested the aid, but there has been a bailout of the Spanish banks, but nobody knows details. The latest plan calls for banks to transfer their non-performing assets into a newly formed “bad bank” (which seems like a redundant term). At some point,the ECB may throw a bone to Greece, maybe not. In other words; the Euro-crisis seems very uncoordinated. 

The European Central Bank will hold their next policy meeting on September 6. The German constitutional court will rule on the legality of the euro zone's new bailout fund on September 12. You may recall, Draghi promised to do whatever it takes to support the Euro-union, yet what can he do before he finds out whether the Germans decide that whatever he is doing is legal or not? Expectations for a successful resolution are greatly diminished. 

 The next Federal Open Market Committee meeting is scheduled for September 13. We are seeing a situation where the US economy is looking a little better, while the economy of the euro zone continues to deteriorate. This is bullish for the dollar and bearish for the euro currency.  There is a slim chance we could see some coordinated action between the Fed and the ECB coming out of Jackson Hole; I doubt it. There is a slim chance that the Fed will take an accommodative move, possibly QE3 during their  September  FOMC meeting; but I doubt it; more likely, they wait till next year – unless.., Unless the ECB and the Germans are so uncoordinated that they can't come up with some program. Inaction, or a lack of action might be very dangerous for the for the Euro-zone. There is a chance the ECB could screw things up over the next three weeks, forcing the Federal Reserve to take action on the 13th. Just something to keep in mind. The way this is likely to play out is deflationary pressures in various parts of the world, especially Europe, along with a flight to quality buying due to the ongoing economic and political problems in the Euro-zone. 

Right now, it looks like the Federal Reserve is fairly satisfied with the idea of 8.3% unemployment and they think that any risk of sustained inflation above 2% per year is unacceptable. The Fed seems to be sanguine in the face of steady job growth in the neighborhood of 150,000 new jobs per month. It is real easy to forget that the economy has been adding jobs, steadily, consistently, for 29 consecutive months. I don't think we've added enough jobs. If you are unemployed, you are certainly not satisfied, but the Fed seems sanguine.

The biggest fear is that the Fed has not set a higher standard for unemployment; it is possible the Fed has set the bar for unemployment and that this will be a self-fulfilling prophecy. Any cyclical decline in the labor force participation rate becomes structural over time as skill loss increasingly excludes those displaced by the depression from reentering the labor force.

There is concern that the bar has been set too low for the economy as a whole.  Once the policymakers believe the economy is operating at full-potential rather than recognizing it is operating at far less than potential, then they start behaving like we can't realistically expect more; they set policy and manage the economy for suboptimal results, and that is exactly what we get. The anticipated becomes the expected and it is the self-fulfilling prophecy. We get what we expect; and our expectations are diminished.The cyclical becomes structural. 

 The Fed has done this, turned the cyclical into the structural in the area of their mandate on price stability; they set a 2% rate of inflation as their target; they did not set a specific, enumerated target for unemployment. The result? We have lingering and high unemployment and we have inflation firmly ensconced below 2%. We have met expectations; the cyclical has become the structural. 

Right now, the Fed acts like it is scared of inflation. They might have good reason; we will likely see higher food prices as a result of the drought; we will likely see higher gasoline prices, despite more domestic oil production and despite conservation efforts. There are some outside forces the Fed can't control but those forces will likely revert to the  mean over time. 

The Fed does control monetary policy and monetary policy still has a huge influence on the economy, on the growth of the economy, on prices we pay in the economy, and on money we earn in the economy. There is an old saying: “don't fight the Fed.” But I wonder if the Fed is still willing to fight, or have they given up? Are they willing to accept the new, suboptimal normal? Are they willing to push the boundaries of 2% inflation? Would Bernanke's head explode if we had 3% inflation?  Is it time for the Fed to step on the throttle and see if they can get all cylinders firing? We usually end up with the economy the Fed wants us to get. 


I mentioned the inflationary pressures on food prices from the drought. For California, the drought is a problem but a bigger problem is not enough farm workers.  Some crops won't get picked this season due to a lack of workers.
Farmers will just leave some crops in the field.  The Western Growers Association reports a 20 percent drop in laborers this year. Stronger border controls are keeping workers from crossing into the US  illegally, and the current guest worker program is not providing enough bodies. The lack of workers is forcing farmers to pay more. Still, it's not enough to attract local labor. 


A UK parliamentary report criticized Barclays ex-Chief Executive Officer Robert Diamond for giving “unforthcoming and highly selective” evidence; the report  faulted the bank for letting traders rig interest rates.

The “candor and frankness” of Diamond’s testimony to lawmakers on July 4 “fell well short of the standard that Parliament expects,” the House of Commons Treasury Committee said in a 122-page report today following its inquiry into the bank’s attempts to manipulate the London interbank offered rate.

“The Barclays board has presided over a deeply flawed culture,” the panel of British lawmakers said. “Senior management should have known earlier and acted earlier.”

Barclays was fined $450 million for manipulating Libor. Barclays’ compliance department was told three times about concerns over Libor, yet these warnings weren’t passed on to senior management, the committee said. Compliance at the bank was “persistently ineffective”, and the actions of Barclays and other traders were “disgraceful” and harmed the reputation of the bank and the industry.  

You see how this sets up for the senior management to get a slap on the wrist and for some “rogue traders to be severely punished?


Foreign banks dominated a key Federal Reserve bank lending program that ran from 2007 to 2010. According to a paper written by Northwestern University’s Efraim Benmelech, the Fed’s lending tool called the Term Auction Facility, TAF, lent directly to deposit taking banks and was created to circumvent many financial institutions’ reluctance to borrow from the central bank’s traditional source of emergency lending, the Discount Window. The research was published by the National Bureau of Economic Research.

Lending via the TAF was substantial and at its peak represented the largest category on the Fed’s expanding balance sheet,  around $500 billion in early 2009 and steadily trailed off as the worst days of the financial crisis passed.

So, what did those foreign banks do with all the money they borrowed from the Fed's TAF, to help keep them afloat? 

Federal and state prosecutors are investigating Deutsche Bank and several other global banks over accusations that they funneled billions of dollars through their American branches for Iran, Sudan and other sanctioned nations

The Deutsche Bank investigation is the latest in a series of cases against global  firms since 2009 that suggests the practice of transferring money on behalf of Iranian banks and corporations flourished under a loophole in United States policy that ended in 2008.

A spokesman for Deutsche Bank declined to comment, but noted that the German bank decided in 2007 that it would “not engage in new business with counterparties in countries such as Iran, Syria, Sudan and North Korea and to exit existing business to the extent legally possible.”

Since 2009, the Justice Department, the Treasury Department and the Manhattan district attorney’s office, working largely in concert, have brought charges against five foreign banks, contending they moved billions of dollars through their American subsidiaries on behalf of Iran, Cuba and North Korea, sponsors of terrorism and drug cartels.

The five banks all included deferred prosecution agreements and required the banks to forfeit some assets. The banks are: ABN Amro, Barclays, Credit Suisse, Lloyds  and ING.

The cases typically have not involved United States banks. Unlike foreign institutions, American banks were prohibited from originating or receiving such transactions from Iran. That enabled them to largely sidestep the conduct that has helped ensnare foreign banks.